Australian bond future prices are higher after a fall in producer prices raised expectations of an interest rate cut in May.

CMC Markets chief market strategist Michael McCarthy said bond prices rose after the Australian Bureau of Statistics released its producer price index (PPI) for the March quarter.

The data showed an 0.3 per cent fall in farm gate and factory gate prices for the first three months of 2012 and boosted expectations of a weak consumer price index (CPI) reading for the quarter on Tuesday.

The Reserve Bank of Australia has indicated it is likely to cut the cash rate from its current level of 4.25 per cent in May if the CPI data shows underlying inflation remains under control.

Mr McCarthy said the market response to the PPI data meant traders had fully priced in a rate cut next month.

“That low reading on the PPI has got market analysts thinking that we are looking at a low-range CPI tomorrow at the core level,” he said.

“And that means that the rate cut the market is anticipating is almost certainly going to be delivered.”

Mr McCarthy said the market had largely overlooked Chinese economic data showing the rate of contraction in the country’s manufacturing sector was slowing.

“I’m not really detecting much of a response to that, it didn’t seem to be the normal risk off response we would have expected.”

HSBC’s purchasing managers index (PMI), which measures factory output, rose to 49.1 in April, up from 48.3 in March, the banking group said in a statement on Monday.

A reading above 50 indicates expansion, while a reading below 50 suggests contraction.

Mr McCarthy said European PMI data overnight and the local CPI data would dominate the bond market’s movements on Tuesday.

At 1700 AEST the June 10-year bond futures contract was trading at 96.295 (implying a yield of 3.705 per cent), up from 96.220 (3.780 per cent) on Friday.

The June three-year bond futures contract was at 96.860 (3.140 per cent), up from 96.780 (3.220 per cent).